Charles Schwab 2015 Annual Report Download - page 71

THE CHARLES SCHWAB CORPORATION
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Millions, Except Ratios, or as Noted)
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conditions, estimated defaults and foreclosures measured by historical and expected delinquencies, changes in prepayment
speeds, LTV ratios, past loss experience, estimates of future loss severities, borrower credit risk measured by FICO scores,
and the adequacy of collateral. The methodology also evaluates concentrations in the loan segments including loan products,
year of origination, and geographical distribution of collateral.
Probable losses are forecast using a loan-level simulation of the delinquency status of the loans over the term of the loans.
The simulation starts with the current relevant risk indicators, including the current delinquent status of each loan, the
estimated current LTV ratio of each loan, the term and structure of each loan, current key interest rates including U.S.
Treasury and LIBOR rates, and borrower FICO scores. The more significant variables in the simulation include delinquency
roll rates, loss severity, housing prices, and interest rates. Delinquency roll rates are estimated from the Company’s historical
loss experience adjusted for current trends and market information. Further, the delinquency roll rates within the loan-level
simulation discussed above are calibrated to match a moving average of the delinquency roll rates actually experienced in the
respective First Mortgage and HELOC portfolios. Loss severity estimates are based on the Company’s historical loss
experience and market trends. The estimated loss severity (i.e., loss given default) used in the allowance for loan loss for
HELOCs is higher than that used for First Mortgages. Housing price trends are derived from historical home price indices
and econometric forecasts of future home values. Factors affecting the home price index include: housing inventory,
unemployment, interest rates, and inflation expectations. Interest rate projections are based on the current term structure of
interest rates and historical volatilities to project various possible future interest rate paths. This methodology results in loss
factors that are applied to the outstanding balances to determine the allowance for loan loss for each loan segment.
Legal and Regulatory Reserves
Reserves for legal and regulatory claims and proceedings reflect an estimate of probable losses for each matter, after
considering, among other factors, the progress of the case, prior experience and the experience of others in similar cases,
available defenses, insurance coverage and indemnification, and the opinions and views of legal counsel. In many cases,
including most class action lawsuits, it is not possible to determine whether a loss will be incurred, or to estimate the range of
that loss, until the matter is close to resolution, in which case no accrual is made until that time. Reserves are adjusted as
more information becomes available or when an event occurs requiring a change. Significant judgment is required in making
these estimates, and the actual cost of resolving a matter may ultimately differ materially from the amount reserved.
The Company’s management has discussed the development and selection of these critical accounting estimates with the
Audit Committee. Additionally, management has reviewed with the Audit Committee the Company’s significant estimates
discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.